Should I Buy a House in the Bay Area?--Running the Numbers

Should I buy a house or rent?  This is a pretty complicated decision.  It involves a variety of factors, one of which is the financial buy vs. rent decision.  Particularly in the Bay Area in communities such as Palo Alto, Menlo Park, and San Francisco, you'll want to run the numbers to make sure buying really makes sense.

Rent vs. Buy Analysis (Link to Model)

When we bought our house, I used the following the spreadsheet.  (blue numbers are variables you can customize to your situation).  If you're just starting and unsure of what values to use here's where you can find out:

Mortgage: Mortgage Link; Fixed or Adjustable Mortgage-Running the Numbers Link

House price: How Much Is a House in the Bay Area Going to Cost? Link

What Are Average Rents in the Bay Area? Bay Area Average Rent Stats Link, Craigslist

Let me know if you have any questions.

At a broader level the two components you should look at are:

Monthly cash flow: The attached model should help you get a sense of what your monthly cash flows might look like. In the Bay Area these are likely to be negative (even after factoring in not paying rent and the tax advantage). How negative cash flow can you take—Depends on your job situation. Smartmoney has a good calculator:

Appreciation: This is highly dependent on two things (a) your time frame (b) your location (c) interest rates. In a place like the Bay Area, this is a huge uncertainty. In the short term, no one knows how prices will act as interest rates go up and local economy recovers. 

The rule of thumb I used was: If the general area is extremely attractive and land is scarce in your neighborhood, as long as I was planning to hold for 5+ years I would be fine. There’s also research that suggests that cap rates do not directly fall in line with interest rates—spreads essentially compensate for interest rate change. This, however, is pretty academic and probably won’t give you much comfort.

Any Bay Area buyer should look at the Housing Bubble Blog just to make sure they are going in with their eyes wide open: Real Estate Bubble? Link

I think at the end of the day, as long as negative cash flows are easily bearable and you either plan to be in the area for a while or can easily rent out, you greatly reduce the risk of a huge loss. Further, if your neighborhood/ community is highly desirable and land is scarce, you should be able to expect appreciation over the long term.

Just avoid the disaster scenario which is where you will be forced to sell when you don’t want to.

If you can't afford an apartment on your own, or it just doesn't make sense based on the analysis, take a look at other options:  The Tenants in Common is a great way to get more value for your dollar. TIC Link

Finally, you should take into account other risks such as asbestos liability and earthquake risk.  These are hard to insure against and can cost you a bundle. Asbestos, Earthquakes and Other Risks Link

Comments

[Ray]

Hi, I was using your program and have a question. On line 102, does the profit include the cashflow on line137? Thanks,

Ray

[eric]

This is a fantastic overview of the house buying decision and a nifty spreadsheet! Many thanks!

[wayne]

I can't figure out why you are adding back principal paid to arrive at Cash Outflows After Principal paid to calculate the IRR.

Pls HELP ME

[AD]

Is it possible to access your spreadsheets without being a Google member? Thanks

[Lindsey at Rentals.com]

This is a great guide for home buying decisions. Did it help you decide whether to go with a rental or a home purchase?